Middle-Market Mergers & Acquisitions Holding Steady In 2013

Begin Planning for an Exit

by Terry Stidham, President of Target Search Group

The middle-market for Mergers & Acquisitions has significantly improved in the past two years according to The Babson College Middle-Market/Small Business Mergers & Acquisitions Survey conducted by the business school’s MBA students in the first quarter of 2013.

Yet according to the report, growth in 2013 will be flat versus 2012 because of a stalled economy, challenges in Washington around tax and estate issues, hesitation by business owners to relinquish, and the gradual recovery in the debt market.

The Babson Survey directed by Babson College Professor Kevin J. Mulvaney in collaboration with members of the Association for Corporate Growth (ACG) and Exit Planning Exchange (XPX), assesses and defines current trends that impact buyers and sellers of businesses. The survey population included leading national middle-market investment banks, large business brokerage firms, advisory professionals, and commercial bankers.

The M&A environment for both small and mid-sized business exits or recapitalizations is stable and may improve in the coming years,” commented Mulvaney, “ It is a very good time for entrepreneur owners to begin planning for their capital event.



Among the survey’s key findings:

Middle-Market Volume is Strong - Small Business M&A Activity Grows at a Slightly Slower Pace

• The volume of middle-market deals is steady and a majority of respondents project a continuation of the current level through the rest of the year. Only 20% of respondents foresee volume increases as the year unfolds.
• Services industry sector remains the strongest with increased activity reported in e-commerce, health and medical services, and aerospace and related industries.
• The small business arena is growing more slowly (an average of 0.5 times increase in EBITDA valuation over 2012) with no expected rise this year in valuations.
• The environment for M&A activity is about the same as a year ago. Babson authors project an increase in the number of private equity buyers in the next eighteen months because of increased debt availability on more acceptable terms.
• Underperforming or weak companies are not viable deals and receive lowball offers and very little interest from financial buyers. The market is willing to pay a premium for revenue growth potential and predictable EBITDA performance.

Buyers Demand High ‘Seller Assistance’ for Smaller Companies

• The percentage of seller assistance (earn outs, deferred money, etc.) continues to be high. The smaller the company (on a $1-100MM survey scale) the higher the demands for seller assistance from the buyer.
• Good news for sellers – the deferred component of the purchase price has dropped from an average of 30% to 20%. The survey also found that sellers are beginning to dig in their heals demanding a larger component of cash up front.

Timeframe to Complete Deals Lengthens

• Due diligence by buyers who have concerns about a sluggish economy and perceived challenges to building revenue will increase deal-making timeframes by a month (formerly 6-9 months). Strategic buyers are also organizing more outside expertise than ever before to prepare their due diligence reports.
• Sellers need patience and must be prepared with information and the ability to respond quickly to buyer requests to increase chances of closing deals within six months. Like buyers, seller success is dependent on acquiring the right legal and deal-making expertise.
• It is still a seller’s market for quality companies. Whether selling or restructuring capital, sellers must develop a knowledgeable game plan to evaluate options and potential deal partners.

Financing for Buyers Grows and Terms Improve

• More financial lenders are making loans with terms that represent a fair balance between what the lender and borrower feel is acceptable.
• The Babson survey projects an increase in the number of opportunities for every type of middle-market financing. This is good news for private equity buyers when balancing leverage versus equity contributions for new M&A deals.
• For smaller deals, there has been a strong rebound in SBA loans especially from community banks, that will help contribute to the growth of small business deals moving forward.
• Surprisingly, the survey found an increase in the percentage of equity needed by qualified buyers of small businesses. This had been a minimum of 20% but some experts see an increase to a minimum of 25%. The increased equity demands from lenders may have contributed to the slow growth of small business sales.
• Middle-market stability is reflected in increased pressure on pricing for financial institutions involved in M&A deals. Yields on mezzanine debt dropped to 12-14% from historical averages of 15-20% and financing costs declined as the volume of financial buyer deals increased.

Top 7 Rookie Buyer Mistakes

Buyer Be Aware 

by Terry Stidham

1.    Not Doing the Math

Let’s say you’re Company A, and you have your eye on acquiring Company B. 

Ideally, 1 plus 1 will equal 3 or something greater.

Then why does it often turn out to be more like 1 plus 1 equals 1.5? 

You need to understand what the combined companies will look like. Start with an analysis of the strengths, weaknesses, opportunities and threats of your company and the same analysis of Company B and then do a combined analysis, the ‘layering effect.’ What are the savings? What are the cross selling opportunities? What the threats, like loss of customers or key employees? Are there any legacy issues that can present problems?

Of course it’s easier to the analysis on your own company (though I am surprised at how often companies don’t) than it is do to it on an acquisition targets, especially a privately held one, but you can still get information on your acquisition target. There are sources like Factiva, Capital IQ, D&B, Google and then there are the industry publications. 

Have your key management speak to other people in the industry to help size up your target. This can help you get a sense of what the two companies really look like together. You also have the right at some point in the process to look under the hood and inspect the books, speak to customers, vendors and key employees. I have developed an in-depth confidential questionnaire to uncover the good, bad and ugly.

2.    Letting Emotions Drive the Deal

As CEO, you are undoubtedly passionate about your business. That’s to be expected and applauded. Getting emotional about completing a deal is different. The tendency is to get excited about the possibilities of buying Company B, and before you know it your enthusiasm becomes infectious, to the point where your key management does not challenge you about downside risks of doing the deal. Getting emotional can keep you in a deal that shouldn't go forward.

3.    Lack of Perspective

Losing perspective is about getting lost in the process. If you've invested a lot of resources – time, talent, money – exploring the deal, it’s easy to think that you have to go forward with the acquisition irrespective of the price you pay. Ask yourself why you want to buy Company B. In your analysis, does it contribute to the top and bottom lines? Do you gain a new distribution channel? Does it eliminate a competitor? Make sure that it is a well-founded rationale and a sound business case that is 
moving you forward, and not the sheer force of momentum. 



4.    Ignoring the Red Flags

There can be hundreds of potential red flags.  Don’t ignore them. Don’t try to justify them away. Dig deeper, ask questions, and if you aren't satisfied with the answers or can’t find resolution, walk away. Red flags are signals to pause or even stop. Failing to do so is often a byproduct of getting caught up in the deal or losing perspective. Don’t close your eyes to the red flags. 

Did Company B have unusual charges or losses that aren't adequately explained?

Does the predictive index (assessment) on the CEO show instability?

Is there unusually high turnover on its management team?

Are there troubles fulfilling orders? If so, why?

Are there cultural gaps or differences in competency levels that will make it difficult to combine people and departments from both companies?

5.   Thinking Inside the Box

Let’s say you see some red flags, or deal just does not make sense. It’s time to review your other options. What if you only bought part of company B? Or maybe it would make sense to partner with another party to do the acquisition.  What about a joint venture? How about structuring the deal where instead of buying Company B for $30 million outright, you pay $20 million upfront and $15 million in potential earn-outs?

It is important to understand your alternatives. I recently had a client who wanted to purchase a company to expand his distribution and increase his overall sales. 

I performed as assessment of his company and the company they were interested in acquiring.  The analysis showed that the client really needed 20% of the target company. Why pay for 100% of a company if you only need 20%?  I recommended that my client partner with one of the other potential acquirers. The end result is that the client paid 10% of the total purchase price for the 20% of the company that he needed.

6.    Not Placing Yourself in the Seller’s Shoes

Your interest and Company B’s are not aligned. You want to pay the lowest price possible and possibly structure the deal with a future payout; they want to get the best price possible—now! Obviously under that scenario you both can’t get what you want and can often stall or kill the deal.

Put yourself in Company B’s shoes to understand why they are selling. Is the CEO looking to retire or play a transitional role? Is Company B being sold at the height of the market? Are there negative trends in the industry that are eluding you?

7.    Failing to Make the Case for the Deal

Try to prove your key points as to why you should acquire Company B.  

Can the two combined cultures really work together or are the management styles and daily ways of operating incompatible?

Can you gain incremental customers or will they leave to go to your competitors?  

Can you really achieve your cost synergies

How will your people and customers fare during the acquisition? 

Can you structure a deal so that you don’t overpay? 

You need to run worst-case, middle-of-the-road case, and best-case scenarios for the acquisition. 

Being aware of these mistakes should help you avoid them. Align yourself with seasoned advisors and remember your real work begins once you complete the acquisition.

Growth Through Acquisitions

Is Now the Right Time? What Comes Next? How to Leverage Success, Keep Growing and Build Business Value?

by Terry Stidham

Target Search Group - Time to Buy

For most prospective buyers, doing an acquisition while the economy still seems so uncertain appears to represent a high risk. Some potential buyers may be building cash balances as a hedge against hard times, rather than a war chest for acquisition – just in case the confused outlook remains for the foreseeable future.

Could right now be the perfect time to grow through acquisitions? Well, it could be if:

• Your company is stable financially and has developed clarity around your financial and personal strategy
• Your strategy is to strengthen the core business by acquiring processes, technology or staff; to create a new complementary division that helps you cross-sell existing business; or to quickly have another local office for geographic expansion.

While the competition is focused on maintenance of their existing customer base, an acquisition could be a very positive solution to growing a successful business. Expansion in both size and capabilities can make a significant new contribution to the P&L and strengthen the company’s position after the recession.

On the Sell Side, it should be no secret that there are many sellers coming in to the market. A generational confluence of aging boomer owners looking for an Exit and a general acceptance of the new economic reality in terms of valuation, suggest a wave of companies for sale will soon be placing downward pressure on multiples and deal terms. Many owners are tired of business management, or they may have specific goals in mind: to shed back office management, gain experienced staff, even have access to additional growth capital. Or they may be very concerned about securing their business value and taking some equity out to protect their financial future.

Having weathered the worst of the recession owners may have realized from this downturn that being an entrepreneur is not always fun and games. The risks – both financial and personal have become more evident, and they may have concluded that managing all aspects of a business may not be for them. Some will seek full time employment, while many will prefer to focus on sales activities, while a partner handles the back office functions for them.

The best positioned buyer firm will have a strategic acquisition plan. Such a plan consistently highlights the growth of profitability, cash flow and business value. Integration and management of an investment is obviously key to success. The use of key metrics and analysis is very important to modeling the pre and post – purchase effects of an acquisition, since many acquisitions fail to achieve their goals because the financial management and oversight of the integration is weak.

While some may see economic uncertainty on the horizon, this period could spell major opportunity for those properly positioned on the buying side.

Contact Terry Stidham – Senior Member of Target Search Group, LLC to  develop an acquisition strategy to take your company to the next level.